Authored by David Dyden via TheNation.com,
America’s favorite investor loves monopoly, not free markets...
After the worst financial collapse since the Great Depression, three officials from the Financial Crisis Inquiry Commission visited Warren Buffett at his office in Omaha, Nebraska. They wanted to ask America’s most successful investor about his 24 million shares in the credit-rating agency Moody’s. The commission would later identify Moody’s and other rating agencies as “key enablers of the financial meltdown,” for granting super-safe triple-A ratings to securities that were backed by junk mortgages. Trillions of dollars’ worth of rotten financial instruments—the fuel of the crisis—“could not have been marketed and sold without [the rating agencies’] seal of approval,” the commission concluded.
During that May 26, 2010, meeting, Buffett deflected responsibility for Moody’s actions. “I knew nothing about the management of Moody’s,” he told the federal investigators, explaining candidly why he owned so much stock: Moody’s faced practically no market competition.
“The single most important decision in evaluating a business is pricing power,” Buffett said. “If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business.” The “big three” rating agencies—Moody’s, Standard & Poor’s, and Fitch—controlled 95 percent of the rating-agency market, an insurmountable advantage over would-be competitors.
“If you’ve got a good enough business, if you have a monopoly newspaper or if you have a network television station,” Buffett concluded, “your idiot nephew could run it.”
Warren Buffett is America’s favorite tycoon. The business community hangs on his every word. The annual meetings at Berkshire Hathaway, Buffett’s conglomerate, have been dubbed “Woodstock for capitalists.” Barack Obama and Hillary Clinton hailed his endorsements in their campaigns for president; even Bernie Sanders has supported Buffett’s position on taxes. The press treats him like a Kardashian, publishing quirky features about his bad eating habits, frugal spending, and hobnobbing with celebrities (an actual headline last November: “Katy Perry Wants to Know What Warren Buffett Thinks of Bitcoin”). An old cartoon show called Warren Buffett’s Secret Millionaires Club featured the so-called “Oracle of Omaha” teaching children how to get rich.
This Nation investigation documents how Buffett’s massive wealth has actually been built: on monopoly power and the unfair advantages it provides. Companies in Buffett’s portfolio have extorted windfall profits, evaded US taxes, and abused customers. In the two specific cases discussed below, in the banking and high-tech industries, Buffett’s investments have prompted federal investigations for anticompetitive or other illegal practices.
Buffett did not respond to repeated interview requests for this article, nor did he reply to questions submitted to his office at Berkshire Hathaway.
Buffett makes no secret of his fondness for monopoly. He repeatedly highlights the key to his personal fortune: finding businesses surrounded by a monopoly moat, keeping competitors at bay. “[W]e think in terms of that moat and the ability to keep its width and its impossibility of being crossed,” Buffett told the annual Berkshire Hathaway meeting in 2000. “We tell our managers we want the moat widened every year.”
America isn’t supposed to allow moats, much less reward them. Our economic system, we claim, is founded on free and fair competition. We have laws over a century old designed to break up concentrated industries, encouraging innovation and risk-taking. In other words, Buffett’s investment strategy should not legally be available, to him or anyone else.
Over the past 40 years, however, the United States has not only failed to build bridges across monopoly moats; it has stocked those moats with alligators. Two-thirds of all US industries were more concentrated in 2012 than in 1997, The Economist has documented. Since the Reagan era, the federal government has abandoned antitrust enforcement, with markets for products like eyeglasses, toothpaste, beef, and beer whittled down to a few suppliers. This consolidation has vastly inflated corporate profits, damaged workers and consumers, stunted economic growth, and supercharged economic inequality.
Buffett professes to be an innocent witness to this perversity, a passive investor observing markets from afar. He is feted as the conscience of American capitalism, a multibillionaire who speaks out about taxing the rich (Democrats even named their tax-fairness plan the “Buffett rule”) and donates his fortune to charity. But Buffett’s example has helped intensify US monopolization, as other investors mimic his approach of finding companies surrounded by moats. The ownership class has subsequently built up unwarrantedly large holdings, concentrating its investment in companies that further increase market power. In other words, Buffett isn’t following America on the road to oligarchy; he’s leading it.
Americans falsely look to these oligarchs to solve our problems, allowing them to amass more power. For example, the recent joint effort by Buffett’s Berkshire Hathaway, Amazon, and JPMorgan Chase to transform the US health-care system is vague and rather mundane—most large companies try to drive down health-care costs by leveraging their size. But when three of the age’s biggest monopolists follow the trend, it’s uncritically treated as front-page news, sending health-care stocks plummeting. A stray press release from Buffett can move billions of dollars in his favor.
Bill Gates of Microsoft, Jeff Bezos of Amazon, and Warren Buffett control more wealth than the 160 million poorest Americans combined. And Buffett doesn’t mind working the system to keep it that way. His net worth as of January is $87 billion, but Buffett says he paid only $1.8 million in taxes in 2015—a mere 0.002 percent of his wealth. According to Barclays, the new Republican tax law is projected to net his business a staggering $37 billion a year.
Free markets are for chumps— Warren Buffett insists on monopoly moats.
Warren Buffett should not be celebrated as an avatar of American capitalism; he should be decried as a prime example of its failure, a false prophet leading the nation toward more monopoly and inequality.
You probably didn’t realize that the same avuncular billionaire controls such diverse companies and products as See’s Candies, Duracell batteries, Justin Boots, Benjamin Moore Paints, and World Book encyclopedias. But Buffett has transformed Berkshire Hathaway, initially a relatively small textile manufacturer, into the world’s largest non-technology company by market value. Berkshire Hathaway owns over 60 different brands outright. And through Berkshire, Buffett also invests in scores of public corporations. The conglomerate closed 2016 with over $620 billion in assets.
The money mainly comes from Berkshire’s massive insurance business, composed of the auto insurer GEICO, the global underwriter General Reinsurance Corporation, and 10 other subsidiaries. Insurance premiums don’t get immediately paid out in claims; while the cash sits, Buffett can invest it. This is known as “float,” and Berkshire Hathaway’s float has ballooned from $39 million in 1970 to approximately $113 billion as of last September. It’s a huge advantage over rival investors—effectively the world’s largest interest-free loan, helping to finance Buffett’s pursuit of monopoly. “[W]e enjoy the use of free money—and, better yet, get paid for holding it,” Buffett said in his most recent investor letter. Indeed, as a 2017 Fortune article noted, with almost $100 billion in cash at the end of that year’s second fiscal quarter, Buffett’s Berkshire Hathaway literally has more money than it knows what to do with.
The dominant narrative around Buffett is that he invests in big, blue-chip companies whose products he enjoys, like Coca-Cola or Heinz ketchup. But Buffett’s taste for junk food cannot match his hunger for monopoly, and he scours the investment landscape to satisfy it. For example, he’s a major investor in the most profitable company you’ve never heard of—one used by hundreds of millions of people worldwide, mostly without their knowledge.
The company is called Verisign, and it operates an essential backbone of the Internet: registries for the domain names .com and .net, among others. If you want to create, for example, MyWebsite.com, you buy the name from a retailer like GoDaddy. But Verisign controls the global registry for .com, so GoDaddy relies on Verisign to connect users to MyWebsite.com. Verisign collects a small fee for this service, usually less than $10 a year. But drawing that fee from an enormous pool of websites results in a massive revenue stream.
As of September 2017, two of Verisign’s domain-name registries, the aforementioned .com and .net, accounted for 145.8 million of the 330.7 million websites in existence, or nearly one in two. Take away the 144.7 million sites tied to a specific country (like .us, or .cn for China), and it’s more like four out of five. Any company controlling 80 percent of a given market can safely be termed a monopoly, though a spokesperson for Verisign said in a statement that “we believe competition is thriving in the market.”
The nonprofit Internet Corporation for Assigned Names and Numbers (ICANN), the registry industry’s main regulator, granted Verisign exclusive contracts to operate .com and .net. Verisign can automatically renew the contracts as long as it meets certain performance metrics. The company was also initially permitted to raise prices gradually, despite the fact that the costs of managing a registry decline over time because the necessary infrastructure is already established.
“If you’re giving a near monopoly in an industry where prices are falling, you would think that you would have terms in the contract to lower the price,” said economist Dean Baker, a critic of government-granted monopolies. Instead, prices for .net domain names can rise 10 percent per year; they’ve more than doubled since 2005, from $3.50 to $9.02 (Verisign’s statement called this price “lower than most competing legacy [top-level domains]”). Prices for .com domain names have also risen, though they are now frozen at $7.85 per year, due to an amended contract executed in 2012. Competitors have offered to run registries at significantly cheaper rates, yet ICANN hasn’t altered Verisign’s contract terms.
Normally, companies with regulated prices aren’t profit-making juggernauts. But in the third quarter of 2017, Verisign’s operating income as a percentage of revenue hit 61.9 percent, putting it near the top of all companies in the S&P 500. This number has climbed steadily since 2006. If the trend continues, sometime in the next decade Verisign will post the highest rate of profitability of any public company on earth.
That may explain why Buffett owns nearly 13 million shares of Verisign stock, worth $1.47 billion as of mid-January 2018. Buffett is famously averse to Internet stocks, but he does like a sure thing. So does the rest of the market: Verisign stock jumped nearly 44 percent in 2017. Buffett’s seal of approval tends to boost fortunes on Wall Street, so more money flows into monopolies.
In 2016, ICANN arranged a blind auction to sell the rights to the .web domain name, seen as a promising competitor to .com. To the surprise of industry observers, an obscure company named Nu Dot Co outbid six rivals for .web, offering a record-shattering $135 million. The mystery was clarified four days later, when Verisign issued a brief press release announcing that it had provided all $135 million for Nu Dot Co’s bid. Already in control of .com and .net, Verisign had wrested control of one of the only plausible alternatives. In its statement, Verisign said that “We intend to launch .web to bring choice and reliability to consumers world-wide.”
Though there were signs of Nu Dot Co operating as a straw purchaser before the auction, ICANN refused to delay the proceedings. Competitors cried foul, arguing that they would have bid higher if they’d known a deep-pocketed foe like Verisign was involved. “ICANN has a history of sweetheart deals with Verisign,” said Jon Nevett, co-founder of Donuts, a competing registry that unsuccessfully sued ICANN to block the .web auction. (The case is now under appeal.)
The Justice Department opened a yearlong investigation into the potential rigging of the .web auction, but in January, the department closed the case. In a research note, JPMorgan Chase called Verisign’s acquisition of the domain name “a very good defensive strategic move, keeping .web out of the hands of the potential competitor.” Verisign’s monopolies remain well guarded—and a continuing source of profits for Warren Buffett.
In 2007, Buffett joked in an investor letter: “If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville [Wright] down…. I have an 800 number that I can call if I get the urge to buy an airline stock,” he added. ” ‘My name is Warren and I’m an air-acholic,’ and then they talk me down.”
Nine years later, Buffett shook off his aversion to airlines. A 2016 stock-buying binge led to Buffett holding approximately 47 million shares in American Airlines, 53 million in Delta, 48 million in Southwest, and 28 million in United, for a total investment of over $9 billion. One day in April 2017, Buffett made $104 million on his airline holdings in a single trading session. The bet is not predicated on any one airline prospering: Buffett holds close to a 10 percent stake in all four major US carriers. (Investments controlling over 10 percent of company stock trigger various paperwork burdens and disclosures, and Buffett has said he likes to stay beneath that threshold.)
What changed between 2007 and 2016? With the blessing of federal regulators, the airline industry became an oligopoly. Four mega-mergers—combining Delta and Northwest, United and Continental, Southwest and AirTran, and American and US Airways—solidified major-carrier dominance in the United States. Today, four airlines control 80 percent of domestic-seat capacity. In 93 of the top 100 airports, either one or two manage a majority of all seats sold.
Market concentration has resulted in higher profits for the airlines and for Buffett, but misery for the passengers: crowded planes, more connections, and a cascade of nickel-and-dime fees. Perversely, by making flying worse, airlines further loosen passengers’ wallets, enticing those who can afford it to buy more legroom, or priority boarding to ensure that their bag gets in the overhead bin. Ancillary fees represented a little over 10 percent of the airlines’ total revenue in 1995; today, it’s more than 25 percent. The public wouldn’t stand for such fleecing if they had a choice, but market consolidation forces customer acceptance.
And it’s not just Buffett: Large index-fund providers like Vanguard and BlackRock have significant industry-wide airline holdings, a factor that may distort competition. “It’s not crazy to think that the CEO of Delta has figured out that Buffett doesn’t like it all that much for him to compete with United,” says Martin Schmalz, an assistant professor at the University of Michigan’s Ross School of Business. Schmalz, José Azar, and Isabel Tecu revised a research paper last year showing that airfares on the average route are 3 to 7 percent higher under common ownership by large investors than they would be under separate ownership. “This is not collusion; it’s not a crime,” Schmalz adds. “But it’s an antitrust problem that increases prices.”
David Dao learned the harsh realities of monopoly air travel last April, after refusing to relinquish his seat to solve an overbooking problem on a United flight. Security agents violently dragged Dao, a 69-year-old physician, down the aisle and out of the aircraft, breaking his nose and knocking out two teeth. The incident gave United a public-relations black eye—video of Dao’s ordeal was viewed over 9 million times, and United’s CEO was hauled before Congress—but it didn’t damage the company’s bottom line. The Department of Transportation declined to prosecute, United’s stock price recovered after an initial dip, and seats remained filled to near capacity.
Throughout the controversy, Buffett stood by United. Assaulting Dao was a “terrible mistake,” he said to CNBC, but “it wouldn’t change the investment strategy.”
Buffett has similarly defended Wells Fargo, his largest single investment, through one damaging scandal after another. In 2016, the bank was caught signing up customers for around 3.5 million fake accounts. Since then, Wells Fargo has also been dinged for issuing clients unwanted insurance and home-warranty products, falsifying records to increase fees on mortgage applicants, overcharging foreign-exchange clients to ring up bonuses, initiating secret changes to mortgage terms for homeowners in bankruptcy, and repossessing the cars of service members while they were on active duty. The federal investigations and fines over this misconduct continue to roll in.
Millions have been harmed by this mix of rank incompetence and outright fraud. But with the five biggest commercial banks—Wells Fargo, Bank of America, Citigroup, JPMorgan Chase, and US Bancorp—controlling nearly half of all assets, as well as robust branch and ATM networks, it can be inconvenient or even impossible not to use their services.
Last August, Buffett called Wells Fargo “a terrific bank…. There were some things that were done very wrong there, but they are being corrected.” In October, he got tougher, blaming Wells Fargo’s board of directors for failing to “remove the stain” on the business and musing about clawing back five years of compensation. But Buffett had supported the same board members for reelection just months earlier. It resembled his decision in 2014 to criticize the board of Coca-Cola for excessive executive compensation, but to abstain from voting on the pay package. At the time, Buffett’s son Howard sat on Coke’s board.
In other words, while Buffett’s wealth and the media attention he attracts enable him to create change inside the boardroom, he takes virtually no responsibility as a major shareholder for the companies he invests in. “He’s following his wallet, not his conscience,” says David Nelson, chief strategist at Belpointe Asset Management.
Windfall profits, taxpayer rip-offs, customer abuse—it’s all in a day’s work for the Oracle of Omaha.
In fact, Buffett is completely enamored with the big banks whose actions sparked the Great Recession, despite a rap sheet as large as Wells Fargo’s. Asked to name his favorite bank in a CNBC interview last October, Buffett replied: “What’s your favorite child?”
As of last September, Buffett’s financial-industry holdings approximate an astonishing $66.9 billion—more than 37 percent of his portfolio. He is Wells Fargo’s largest shareholder, and he recently became the largest shareholder in Bank of America as well, the result of a post-financial-crisis deal allowing Buffett to convert an injection of capital into common stock. That conversion earned him $12 billion overnight. A similar crisis-era investment in Goldman Sachs spawned a $3 billion payday.
Buffett also holds major stakes in Bank of New York Mellon, US Bancorp, and M&T Bank. He has a hand in every major credit-card issuer: American Express, Visa, MasterCard, and Synchrony Financial, which provides private-label credit cards to retailers. While Buffett doesn’t own stock in JPMorgan Chase, his top deputy Todd Combs sits on the board, obviously aware of the activities of the leading competitor to his boss’s banking investments.
You may think you have a choice of financial institutions, but when you pull out a piece of plastic to pay for anything, chances are you’re enriching Warren Buffett.
It would be one thing if Buffett were passive about investments he doesn’t totally control but scrupulous regarding the businesses owned within Berkshire Hathaway’s portfolio. But only 25 people work at Berkshire’s headquarters, overseeing 63 companies and more than half a trillion dollars in assets. It’s impossible for Buffett to be anything but an absentee owner, instructing portfolio managers to gain market share but ignorant of how they do it. And anyone who has watched Buffett operate over the past 40 years knows his preferred path to wealth: through monopoly.
Among his first investments were newspapers, including the 1977 purchase of the Buffalo Evening News. Buffett immediately targeted the News’s rival, the Courier-Express, by launching a Sunday edition. By 1982, the Courier-Express was out of business, and Buffett’s local monopoly became his largest single investment. Even today, despite the Internet, Buffett owns 31 daily newspapers, most of them local monopolies.
A more brutal example involves Berkshire Hathaway subsidiaries Clayton Homes, the nation’s largest mobile-home builder, and Vanderbilt Mortgage, its companion lender. A series of journalistic investigations in 2015 found that the companies targeted minorities with high-pressure sales tactics, issuing loans swollen with hidden fees. African-American, Native American, and Latino borrowers received higher interest rates, even if their fellow white borrowers earned less. When the loans failed, Clayton repossessed and resold the homes, earning more fees each time. The Consumer Financial Protection Bureau’s complaint databases are littered with hundreds of comments about Clayton and Vanderbilt. “This type of behavior by any lender is despicable and absolutely intolerable,” wrote one complainant.
Buffett has publicly defended the businesses, which earned $744 million in 2016. He even tried to attack the credibility of a critical reporter, because the reporter’s sister worked at a law firm that sued Clayton. In 2017, Buffett vowed that Clayton Homes would grow, despite admitting that it foreclosed on one out of every 40 properties the previous year—over three times the national average.
Last December, the House of Representatives passed a bill to further deregulate the manufactured-home industry, eliminating consumer protections and disclosure requirements under statutes like the Truth in Lending Act. If the bill becomes law, Clayton Homes salespeople could legally steer borrowers to high-cost loans, which traditional mortgage brokers are barred from doing. As Maxine Waters, ranking Democrat on the House Financial Services Committee, said on the House floor, “This bill makes it easier for financial titans like billionaire Warren Buffett to earn even more profits, at the expense of some of the most vulnerable consumers in this country.”
The disparity between Buffett’s words and actions is an enduring feature. His main entry into the political arena involves a plea for tax fairness, to “stop coddling the super-rich.” But Buffett’s third most valuable stock holding (after Wells Fargo and Kraft Heinz) is a $22.8 billion investment in Apple, perhaps America’s most notorious corporate-tax evader, famous for stashing profits in offshore tax havens.
Buffett takes full advantage of tax loopholes. He uses Berkshire Hathaway, a valuable tax shelter, for his investments. The Republican tax bill will save Berkshire an estimated $37 billion, because the firm habitually defers its tax liabilities, which will now be paid off at a much lower rate. Even the infamous ”private-jet tax break” in the bill is really an extrajudicial attempt to settle a dispute between the IRS and NetJets, a private-plane company wholly owned by Berkshire Hathaway.
“I think idolizing buffett is unhealthy,” says Robin Harding, Tokyo bureau chief for the Financial Times, who offered a rare note of criticism of the billionaire investor in the business press last September. “We should lionize entrepreneurs…who take bold risks by investing to make our lives better,” Harding adds. “Buffett’s whole method…is to minimize risk by building moats while investing to buy a greater share of what already exists.”
Former Supreme Court Justice Louis Brandeis called businesses like Buffett’s, which use other people’s money to create personal fortunes, the “Money Trust.” These financier middlemen “bestride as masters of America’s business world, so that practically no large enterprise can be undertaken successfully without their participation or approval,” Brandeis wrote. Buffett routinely takes advantage of opportunities unavailable to ordinary investors: The mega-bank Goldman Sachs created an internal “brain trust” solely to pitch deals to people like Buffett. “The kind of trades he does today no one else can do—you gotta be that big,” explains David Nelson of Belpointe Asset Management.
Buffett’s fortune reflects a change in whom modern capitalism serves. Former labor secretary Robert Reich, whose latest book, Saving Capitalism, was recently adapted into a Netflix documentary, explained that the wealth generated through corporations used to be shared somewhat more with workers, communities, and the broader economy in what he termed “stakeholder capitalism.” “That changed in the 1980s, when the corporate raiders insisted that CEOs only focus on maximizing shareholder returns,” Reich says. “Even if companies wanted to be sustainable, they’re not able to under the current system.”
Amazingly, Buffett has spearheaded an effort to promote “commonsense corporate governance principles,” joining the CEOs of America’s largest corporations, from General Motors to JPMorgan Chase. The group’s manifesto states that “[o]ur financial markets have become too obsessed with quarterly earnings forecasts,” recommending that institutional investors make informed decisions about the direction of the companies they hold. But this is precisely what Buffett never does; he openly ignores management performance in favor of finding businesses with moats. This has become his perfect excuse: Buffett evades responsibility for abuses of market power, preserving his pristine reputation by passing the buck.
Nor does Buffett acknowledge his role in driving further monopolization. The investment-research firm Morningstar has created the “economic moat” index to track the 20 companies with the highest walls around their businesses. The money-management firm VanEck sells an exchange-traded fund based on that index called “MOAT.” Companies like Valeant Pharmaceuticals scoop up lifesaving drugs that nobody else makes and jack up the prices; it’s the moat strategy taken to its logical extreme. “We’re seeing this almost spontaneous decision across whole industries that they’re going to milk existing market positions rather than compete aggressively,” Harding says.
Buffett says he supports fairer taxes, but owns $22 billion of tax evader Apple.
What’s the answer? First off, aggressive antitrust enforcement. “What the framers of the antitrust laws…were concerned about is unreasonable market power that gives companies the chance to engage in predatory behavior of consumers and political power,” Reich says. Companies like Verisign, which exploit their monopolies, should face greater scrutiny. Dominant players in industries like airlines and banks should be downsized. Sprawling investors like Buffett also present concerns. “If we didn’t allow Buffett to own substantial stakes in all air carriers, the problem would be significantly reduced,” says the University of Michigan’s Martin Schmalz.
We must also consider disproportionate capital concentration. The top 1 percent owns a significant portion of all wealth, and it increasingly makes money just from having money. Globally, 82 percent of the wealth generated in 2017 flowed to that top 1 percent, according to Oxfam. Through dividends, interest payments, and rising investments—Buffett-style passive ownership—the holders of capital capture about 30 percent of national income, according to research by Thomas Piketty, Emmanuel Saez, and Gabriel Zucman. “If you’re well diversified and you just chill out, you will make a lot of money without doing much for it,” says Matt Bruenig, founder of the People’s Policy Project.
Bruenig has proposed a wealth tax, with the revenue directed into a stock-accumulating sovereign-wealth fund. Citizens could receive a direct dividend from the gains, the way Alaskans receive a check from the state’s Permanent Fund. Instead of someone like Buffett hoarding wealth to extract income, we would all benefit in service to a fairer society. And as with Norway’s wealth fund, the government could involve itself more directly in corporate governance, as a countervailing force to shareholder tyranny.
Getting serious about taming monopolies also means ceasing the endless praise of Warren Buffett. Leading Democrats and the press have given him a pass for decades. But the path to solving America’s inequality crisis goes through Omaha and the cuddly billionaire whose love of monopoly is contributing to national desperation. “He’s a really good investor,” David Nelson says of Buffett. “I’m not sure he’s much of an example on anything else.”

European stocks dropped, Asian and EM market rose, and S&P were lower by 0.3% as investors assessed the latest overnight carnage in the USD which plunged to the lowest level since the start of 2015, sending the USDJPY tumbling to 107, the euro extending gains to just shy of $1.21 and a slowdown in China’s export growth which however did not prevent the Yuan from posting its best weekly gain on record.
It was all about the seemingly huge currency moves overnight as the dollar plunged for the 7th day in a row, the biggest 7 day drop in 4 months, amid doubts about further Federal Reserve tightening, North Korea tensions and as Hurricane Irma threatens South Florida. The Yen rose to the strongest level against the dollar since Nov. amid nervousness about possible provocation from North Korea ahead of its foundation day on Saturday; yen surged past 108 per dollar as options barriers gave way, triggering a series of stop-losses. The Yuan rallied toward 6.45/USD in both onshore and offshore markets as traders speculate PBOC will tolerate a stronger currency after it rose past the psychological 6.50 mark Thursday. The Australian dollar surged to the highest in more than two years on the back of dollar weakness while the cherry on top was the 10Y TSY yield touching a YTD low of 2.014% before rebounding to ~2.035%.
Meanwhile, natural disasters were aplenty, including the most powerful earthquake this century to shake Mexico, while Hurricane Irma is projected to hit Florida Sunday, and North Korea is widely expected to launch an ICBM on its September 9 holiday.
As reported last night, the big overnight story was the dramatic plunge in the dollar in Asian trading....
... which also pushed the EURUSD to the highest level since January 2015, a move that was not helped by this morning's Reuters "trial balloon" according to which the ECB was considering 4 QE reducing scenarios.
“At its current level, the Euro is not a threat for the Eurozone,” Philippe Ithurbide, global head of research at Amundi Asset Management, said in a report. “If the euro stabilizes, or continues a gradual appreciation path as in our base scenario, the ECB could announce -- maybe in October -- a reduction, starting in January 2018, of the quantitative easing program. Should the euro continue to appreciate rapidly, the ECB could become more dovish and postpone its tapering.”
This morning, the USD has attempted to stabilize after said heavy selling in Asian session, which has seen the DXY hit a fresh YTD low. Meanwhile, the USD/CNH has bounced from levels last seen in Dec. 2015 after reports of Chinese concerns on yuan strength. The Yuan was set for its best weekly gain since records began in 2007. The onshore yuan headed for the third weekly advance in a row, with a gauge of the dollar tumbling toward the biggest decline since May. The CNY climbed 0.48% to 6.4543 per dollar as of 5:11 p.m. in Shanghai on Friday; extending the weekly advance to 1.6%, the most since Bloomberg began compiling CFETS data in 2007. On Friday morning, the PBOC strengthened the daily reference rate by 0.36% to 6.5032 per dollar, extending the 10-day run of increases to 2.4%. The Bloomberg replica of CFETS index, which tracks the yuan against 24 currencies, climbs 0.10% to 95.16
The Yuan’s recent appreciation has been bigger than expected - and it’s also more than what can be explained by the dollar’s moves - which is likely driven by strong corporate dollar selling and positive market sentiment, UBS economist Wang Tao writes in report sent Friday. "Allowing the yuan to gain versus the basket is a step toward convincing the market of increased two-way flexibility; not expecting it to embark on a multi-year appreciation path in effective term" Wang adeded.
According to Reuters, China policy makers are increasingly worried a sharp CNY rally could hurt exports and the economy, however China is unlikely to intervene forcefully to cap the CNY due to worries of criticism from the US.
Overnight, NY Fed president Bill Dudley became the latest U.S. central banker to lay out his views ahead of a policy-setting meeting later this month as expectations for an interest-rate increase have been scaled back. According to Bloomberg, Dudley reiterated the need to continue raising rates while conceding that the Fed may have to rethink its inflation model.
USD/JPY holds close to overnight levels after tripping downside stops through 108.00. As noted earlier, Bund futures sell off after latest ECB sources give more details on potential tapering, curve steepens. Treasurys partially retrace overnight spike higher, precipitated by the USD weakness.
In equities, European equity markets open lower and slowly grind back to unchanged led by bank sector, Santander +2.5% after being upgraded at Morgan Stanley. Mining sector underperforms after base metals sell off aggressively in response to China trade data. Stocks in Europe struggled for traction as the euro extended its march above $1.20, while S&P 500 index futures dropped. The most powerful earthquake this century shook Mexico, adding to investor anxiety.
Asia equity markets traded mixed following similar indecisiveness in US and as the region digested a slew of economic releases including Japanese GDP and Chinese Trade data. ASX 200 and Nikkei 225 were lower as financials mirrored the underperformance in their US peers, with Japan also dampened by a weaker than expected Final Q2 GDP which showed the largest downward revision since the current accounting method began in 2010. Shanghai Comp. and Hang Seng were positive despite another OMO skip by the PBoC which resulted to a larger net weekly liquidity drain W/W, as strength in property and energy names kept sentiment upbeat while traders mulled over the release of mixed Chinese Data. China released its latest trade balance data which showed that Exports missed, but Imports surpassed expectations to suggest strong domestic demand. Exports growth for China moderated to 5.5% yoy in August from 7.2% yoy in July, below expectations, while imports growth was up to 13.3% yoy from 11.0% yoy in July, above consensus. In sequential terms, exports contracted by 0.4% mom sa, albeit less than that in July ( -2.0% mom sa). Imports increased by 2.9% mom sa, rebounding from -1.9% mom sa in July. The trade surplus moderated to US$42.0bn from US$46.7bn in July
Chinese Trade Balance (CNY)(Aug) M/M 286.5B vs. Exp. 335.7B (Prev. 321.2B)
Chinese Exports (CNY)(Aug) Y/Y 6.90% vs. Exp. 8.70% (Prev. 11.20%)
Chinese Imports (CNY)(Aug) Y/Y 14.40% vs. Exp. 11.70% (Prev. 14.70%)
Meanwhile, the threat from North Korea lingers. U.S. President Donald Trump said it’s not “inevitable” that the U.S. will wind up in a war with North Korea over its continued development of nuclear weapons, though military action remains an option. Pyongyang may test a missile this weekend to coincide with its “founding day” on Sept. 9.
Ten-year Treasury yields fell toward 2 percent and gold headed for a third week of advance ahead of a potential North Korean missile launch. Copper led most industrial metals lower and crude oil dropped. The yield on 10-year Treasuries declined less than one basis point to 2.04 percent, the lowest in 10 months. Britain’s 10-year yield advanced one basis point to 0.982 percent.
West Texas Intermediate crude fell 0.4 percent to $48.91 a barrel, the largest fall in more than a week. Gold gained 0.2 percent to $1,351.25 an ounce, the strongest in almost 13 months. Copper declined 1.4 percent to $6,802.00 per metric ton, the lowest in more than a week on the largest drop in more than four months.
Economic data include wholesale inventories.
Market Snapshot
S&P 500 futures down 0.4% to 2,455.75
STOXX Europe 600 down 0.2% to 374.04
German 10Y yield fell 1.3 bps to 0.294%
MSCI Asia up 0.4% to 161.82
MSCI Asia ex Japan up 0.4% to 534.48
Nikkei down 0.6% to 19,274.82
Topix down 0.3% to 1,593.54
Hang Seng Index up 0.5% to 27,668.47
Shanghai Composite down 0.01% to 3,365.24
Sensex up 0.03% to 31,671.21
Australia S&P/ASX 200 down 0.3% to 5,672.62
Kospi down 0.1% to 2,343.72
Euro up 0.2% to $1.2046
Italian 10Y yield fell 10.2 bps to 1.634%
Spanish 10Y yield rose 1.6 bps to 1.511%
Brent Futures up 0.5% to $54.76/bbl
Gold spot up 0.4% to $1,354.10
U.S. Dollar Index down 0.4% to 91.27
Top Overnight News
Reuters: ECB discussed scenarios yesterday and agreed the next step is to cut stimulus but should be done with broadest possible consensus; options included reduction to EU20b or EU40b and extension by 6 or 9 months, according to people familiar; ECB’s Liikanen: Some QE decisions will be taken in December
Fed’s Dudley: Appropriate to continue to remove monetary policy accommodation gradually, low inflation may be structural; Fed’s George says it’s time to continue with Fed rate hikes
President Donald Trump said it’s not “inevitable” that the U.S. will wind up in a war with North Korea over its continued development of nuclear weapons, but that military action remains an option
Trump suffered another setback on his travel ban, with an appeals panel leaving in place a lower-court ruling that forces the administration to accept people with grandparents, cousins and other relatives in the U.S.
Traders braced for economic damage to Florida from Hurricane Irma, set to make landfall on Sunday. The most powerful earthquake this century shook Mexico, adding to investor anxiety and sending the peso weaker
Federal Reserve Bank of New York President William Dudley reiterated the need to continue raising interest rates while conceding that the U.S. central bank’s inflation model may be in for a rethink soon
White House is considering at least six candidates to be the next head of the Fed; a chance Yellen will be renominated, though Cohn’s prospects have dimmed according to people familiar
Chinese officials are beginning to worry about the rallying yuan due to the strain on exporters, according to people familiar: Reuters
China Aug. Trade Balance: +$41.9b vs +$48.5b est; Exports 5.5% vs 6.0% est; Imports 13.3% vs 10.0% est.
Delta Cancels Flights for South Florida Airports on Irma
Strongest Quake in Century Hits Mexico, at Least Three Dead
White House Is Said to Be Considering at Least Six for Fed Chair
Equifax’s Historic Hack May Have Exposed Almost Half of U.S.
U.S. Is Said to Target North Korea Violators, With ZTE’s Help
BlackRock Is Said to Be in Talks for Calpers’s Buyout Business
ECB Is Said to Study QE Options That Don’t Need Rule Tweaks
Apple-Backed Billionaire Makes Case to Buy Toshiba Chip Unit
China’s Export Engine Slows as Imports Maintain Steady Gains
Asia equity markets traded mixed following similar indecisiveness in US and as the region digested a slew of economic releases including Japanese GDP and Chinese Trade data. ASX 200 and Nikkei 225 were lower as financials mirrored the underperformance in their US peers, with Japan also dampened by a weaker than expected Final Q2 GDP which showed the largest downward revision since the current accounting method began in 2010. Shanghai Comp. and Hang Seng were positive despite another OMO skip by the PBoC which resulted to a larger net weekly liquidity drain W/W, as strength in property and energy names kept sentiment upbeat while participants also mulled over the release of mixed Chinese Data where Trade Balance and Exports missed, but Imports surpassed expectations to suggest strong domestic demand. 10yr JGBs gained amid the risk averse sentiment in Japan and as yields tracked the declines seen in their US counterparts, while the BoJ were also present in the market for a total of JPY 880bln of JGBs across the curve. China policy makers worry a sharp CNY rally could hurt exports and the economy; China unlikely to intervene forcefully to cap the CNY due to worries of criticism from the US, according to sources.
Top Asian News
Tencent’s Giant Rally Is a Problem for Some China Investors
SpiceJet Shows Long-Haul Intent With Boeing-Airbus Contest
Japan’s GDP Growth Revised Down on Softer Capital Expenditure
Citi Sees Pressure on Yuan, Philippines Peso Amid Reserves Trend
China No. 4 Developer Seeks to Repay Overdue Debt at Lower Rate
Topix Has Worst Week Since April on N. Korea, Natural Disasters
Yuan Surge Feeds Speculation Policy Makers to Loosen Control
Soft risk off tone has highlighted this lacklustre Friday morning, as much of the price action was seen yesterday. Equity markets
opened marginally lower and have traded around these levels from the open with 8/10 Euro Stoxx sectors trading in the red. The
stronger EUR has supported the mild risk-off tone following yesterday’s ECB meeting and the EUR continuing to ramp.
Stock specific sees basic resources struggling, being affected by the pressure of copper prices, elsewhere the finance sector is one
to trade in the marginal green, buoyed by Morgan Stanley’s upgrade of Santander. Peripheral bonds are seeing slight downward pressure, likely due to profit taking following yesterday’s outperformance amid the
ECB press conference. Price action across European curves has been quiet, as the EU AAAs all trade around levels seen in the
open.
Top European News
U.K. Manufacturing Jumps, Construction Falls as Quarter Starts
Akzo Nobel Warns on 2017 Profit as Paintmaker Replaces CFO
Nordea Move Has Riksbank Chief Warning of Dangerous Fallout
Swedish Government Backs Away From Plan to Cut Riksbank Reserves
Overlooked in Cancer, Glaxo and Sanofi Look to Get Into the Race
Greene King Shares Slump on Trading Update, Dragging Pubs Lower
Mercedes Fields Buzz Aldrin to Take on BMW While Fiat Stays Home
Trinity Mirror Starts Talks to Buy Desmond’s U.K. Tabloids
Germany’s Facebook Case Tackles Crucial Digital Issues: Mundt
FX markets have seen subdued trade following yesterday’s volatility being followed by an attack on the greenback overnight. Much anticipation was on the UK Manufacturing and Industrial Production data, the formers slight beat vs. expected sparked little sterling buying, with the data causing no real price action. USD/JPY broke through the 108 handle during the Asia/European crossover, knocking through option barriers on the way through. The week’s aggressive buying between 108.00/108.50 has aided with the bearish pressure, as stops were triggered through the 108.00 level, now firmly through April’s low. July 16, 2016 high has paved some support for the pair, however, a break through 107.50 is likely to see a 105 print.
In commodities, the US storms remain a concern to energy traders, the catastrophic events are likely to lead to refiners and recovery projects competing for the same labour, in turn driving up costs or causing labour shortages. Brent futures have flipped back into its pre-hurricane backwardation after fears of a significant drop in crude demand failed to leak into markets. Copper has been the noticeable laggard in metal markets, as the precious metals all perform well amid the risk-off tone.
Looking at the day ahead, there is the final reading for wholesale inventories
along with consumer credit data. Away from the data, the Philadelphia
Fed President Harker will speak on consumer behaviour in credit.
US Event Calendar
8:45am: Fed’s Harker Speaks on Consumer Finance in Philadelphia
10am: Wholesale Inventories MoM, est. 0.4%, prior 0.4%; Wholesale Trade Sales MoM, est. 0.5%, prior 0.7%
3pm: Consumer Credit, est. $15.0b, prior $12.4b
DB's Jim Reid concludes the overnight wrap
So unsurprisingly the talk of the town over the past 24 hours has been the ECB and President Draghi. As expected there was no change to policy but that was never going to be the talking point. Draghi did however more or less confirm that a decision on tapering will likely be taken at the October meeting. A “very, very preliminary discussion” was said to have taken place within the governing council yesterday but the “bulk of decisions” will be made in October for beyond 2017 according to the President.
The biggest focus going into the meeting though was on what sort of rhetoric we would get from Draghi around the recent strength in the currency. While questioned and addressed at least half a dozen times, the general feeling was that Draghi felt relatively comfortable suggesting that he and the council view Euro strength as a sign of improving economic fundamentals. That gave the green light for the single currency to rally another +0.89% yesterday and so close above 1.200 for the first time since January 2015. This morning it’s up further, at 1.2070 as we go to print. The President did yesterday highlight up front that “the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring” along with making various other references. However Draghi also played up growth and failed to really downplay inflation. Draghi called growth “robust” and “broad based” and signalled that the ECB had upgraded this year’s growth forecast to 2.2% from 1.9%. 2018 and 2019 forecasts were left unchanged. On inflation the impact of the recent currency move was to only shade one-tenth off the 2018 and 2019 headline forecasts, and leave 2017 as is at 1.5%. That said core inflation expectations were revised down in 2019 by twotenths. Overall though it felt a bit like every time Draghi tried to downplay the currency he ended up caveating it with a positive.
Away from that, another notable snippet from the press conference included Draghi saying that the ECB “haven’t really discussed the scarcity issue (for bond buying) because so far we’ve consistently shown that we’ve been able to cope with this issue quite successfully”. DB’s Mark Wall summed up in his report by saying that his baseline expectation is a “slow and extend” decision on QE at the October meeting, extending until mid-2018 at the slower rate of EUR40bn per month. He expects a dovish tightening and notes that the ECB could achieve this by justifying slower QE on the basis of partial normalisation of core while saying that full normalisation is susceptible to FX appreciation, and also maintaining the QE guidance by saying that the Bank is prepared to do more if necessary.
The failure to temper the move in the currency resulted in an interesting market dynamic as it essentially cleared the path for European bonds to rally. 10y Bund yields closed -4.1bps lower at 0.302% and the lowest since late June. France and Netherlands were -5.0bps and -4.5bps lower respectively while the periphery outperformed with yields in Italy, Spain and Portugal -11.1bps, -7.3bps and -10.5bps respectively. The Stoxx 600 also rebounded from an early fall to close +0.27%.
Meanwhile across the pond, 10y Treasuries plunged to a new YTD low during the day of 2.032% and are continuing to flirt with that 1% handle. They eventually closed just off that at 2.040% which is where they are this morning. That move for Treasuries appeared to be more European led but clearly the threat of Hurricane Irma (and two other Hurricanes) inching closer to Florida and reports per Bloomberg about another possible missile test by North Korea is keeping the bond market propped up. The cloud hanging over the Fed now with the all the antics in Washington and an uncertain Fed Board composition is clearly not helping too. The S&P 500 closed virtually flat (-0.02%), but within the sectors, health care rose but banks (-1.76%) and insurers (-1.90%) were hit given the potential drags from lower bond yields and Hurricane Irma respectively. Elsewhere, the US dollar index fell -0.68%, Gold rose +1.12% to a new one-year high but WTI Oil was little changed.
On the topic of uncertainty, the feeling was that it might be a two-horse race between Janet Yellen and Gary Cohn to be the next Fed Chair, but Bloomberg reported last night that Trump may be considering six more possible candidates for the top job. The list is fairly broad and includes: Kevin Warsh (former Fed governor), Glenn Hubbard (professor at Columbia Uni.), John Taylor (professor at Stanford Uni.), Lawrence Lindsey (former economic advisor to President Bush), Richard Davis (former US Bancorp CEO) and John Allison (former CEO of BB&T). With the various other departures on the Board, Trump is going to have a rare opportunity to handpick and reshape the composition of the Federal Reserve. However as we’ve been saying in recent days, this very much keeps the clouds of uncertainty from dissipating over the Fed for a while.
On a related note, following up from the Fed’s Vice-Chair Stanley Fischer’s early resignation the other day, our US team took a closer look at the potential implications. They argue that the FOMC has lost one of its more hawkish members and with the December FOMC decision already on a course to be contentious, it is possible that there could be at least three dissents to a rate hike decision.
This morning in Asia, markets are heading into the end of the week a bit mixed. The Nikkei (-0.38%), Kospi (-0.13%) and ASX 200 (-0.36%) are all softer but the Hang Seng (+0.50%) and Shanghai Comp (+0.24%) have edged higher. It’s worth noting that trade data in China this morning showed export growth as slowing to +5.5% yoy in Dollar terms from +7.2%. Expectations were for a slower decline to +6.0%. Imports on the other hand surged to +13.3% yoy from +11.0% after the consensus was also for a slowdown in the growth rate. It’s worth noting that this is the second month in a row that export numbers have disappointed.
Back to the US debt ceiling. Now that the September deadline has been extended to December, President Trump suggested yesterday that there are “a lot of good reasons” to get rid of the debt ceiling altogether. Senate minority leader Schumer and Senate Finance Chairman Hatch along with others supports the idea, but some do not, including House Speaker Paul Ryan who said that “there is a legitimate role for the power of the purse and Article One powers”.
Staying with the US, we’ve had two more Fed speakers in the last 24 hours. The usually hawkish Cleveland’s Fed President Mester said she is “comfortable” raising interest rates again this year and added that not hiking rates between now and March 2018 is not her idea of a gradual rise. Elsewhere, The NY Fed President Dudley said that “I expect the US economy will perform quite well… as this occurs, I anticipate that wage growth will firm and price inflation will gradually rise” and that “we will continue to gradually remove monetary policy accommodation”.
Moving on. The latest on Brexit talks yesterday saw EU Chief Brexit negotiator David Barnier say “I’ve been very disappointed by the UK position…there is a moral dilemma here, you can’t have 27 (states) paying for what was decided by 28” and that “the UK needs to tell us what it wants and we will see what is possible”. Elsewhere, the President of the European Parliament, Antonio Tajani, said “it would seem very difficult that sufficient progress can be achieved by October”. Here in the UK, the Guardian noted that PM May has rejected an invite to address the EU Parliament to explain Britain’s position, instead preferring to discuss with leaders in closed sessions.
Before we take a look at today’s calendar, a quick recap of yesterday’s economic data. In the US, the initial impact of Hurricane Harvey has seen initial jobless claims rise 62k to 298k (vs. 245k expected), with applications in Texas up 52k. Continuing claims were broadly in line at 1,940k (vs. 1,945k expected). Elsewhere, the final reading for nonfarm productivity was above market at +1.5% qoq (vs. +1.3% expected), resulting in a through-year gain of +1.3% yoy.
Back in Europe, the final reading on the Eurozone’s 2Q GDP was unrevised at +0.6% qoq and +2.3% yoy (vs. 2.2% expected). In Germany, July industrial production was flat (vs. +0.5% mom expected), but annual growth is still up +4.0% yoy (vs. +4.6% expected). In the UK, the Halifax house price index was well above market at +1.1% mom (vs. +0.2% expected) and +2.6% yoy (vs. +2.1% expected). Over in France, the trade deficit widened to EUR6.0bn in July, with +4.9% yoy growth in exports outpaced by +9.2% yoy growth in imports.
Looking at the day ahead, Germany’s trade balance, current account balance and export / imports stats are due this morning. For the UK and France, industrial production (+0.2% mom expected for UK; +0.5% mom for France), manufacturing production and trade balance stats are also due. Over in the US, there is the final reading for wholesale inventories along with consumer credit data. Away from the data, the Philadelphia Fed President Harker will speak on consumer behaviour in credit.

Denying yesterday's WSJ report that Trump has "fired" Gary Cohn from his future role as Fed chair due to his strong opposition to Trump's handling of the Charlotteville tragedy, Bloomberg reports that the White House is considering "at least a half-dozen candidates to be the next head of the Federal Reserve, including economists, executives with banking experience and other business people"
The breadth of the search goes against the narrative that has taken hold in Washington and on Wall Street that the Fed chair nomination is a two-horse race between National Economic Council Director Gary Cohn and current Fed Chair Janet Yellen, whose term expires in February.
Actually, according to many, including online betting markets, the race has - for a while - been between mostly Yellen and Kevin Warsh, who as of today are both neck and neck in their online odds of being nominated Fed chair on February 4.
Previously, President Donald Trump said that both Yellen and Cohn, were being considered for the top Fed job. Since then, Cohn’s prospects have grown cloudy after he publicly criticized remarks the president made in the wake of racially-charged violence in Charlottesville, Virginia. The Wall Street Journal reported Wednesday that Trump is unlikely to pick Cohn for the post, and three people close to Trump told Bloomberg that Cohn’s prospects for the Fed job have dimmed.
But three people familiar with the process say Trump is not yet deeply focused on the search. It is still being conducted by staff who aren’t ready yet to present him with a short-list of vetted candidates. John DeStefano, the president’s chief personnel recruiter, is in charge of the search, one person said.
Trump’s former chief strategist Steve Bannon, who clashed with the more moderate Cohn inside the White House before his departure last month, told 60 Minutes in an interview to be broadcast Sunday that Cohn should “absolutely” resign.
“It’s been glacial in filling some of these jobs, which is surprising because the president during the transition” talked a lot about “retaking control” of the central bank, said Jaret Seiberg, a Washington policy analyst for Cowen & Co. in an interview with Bloomberg Television.
Acording to Bloomberg, some of the other possible contenders include former Fed Governor Kevin Warsh - a vocal opponent to the Fed's destructive groupthink - as well as Columbia University economist Glenn Hubbard and Stanford University professor John Taylor, one of the people familiar said. Bloomberg adds that Lawrence Lindsey, a former economic adviser to President George W. Bush, has been discussed. Former US Bancorp CEO Richard Davis and John Allison, the former CEO of BB&T Corp., have also been considered.
Meanwhile, here is the list of most likely candidates according to PredictIt, which after yesterday's drop in Cohn odds, has Warsh back on top and the most likely next Fed chair:

Authored by Wolf Richter via WolfStreet.com,
Magnitude unknown but huge. Brokerages push it to new heights.
Stock and bond market leverage is everywhere. Some of it is transparent, such as NYSE margin debt which was $539 billion as of the June report. But the hottest form of stock and bond market leverage is opaque, offered by financial firms that usually don’t disclose the totals: securities-based loans (SBLs) — or “shadow margin” because no one knows how much of it there is. But it’s a lot. And it’s booming.
These loans can be used for anything – pay for tuition, fix up that kitchen, or fund a vacation. The money is spent, the loan remains. When security prices fall, the problems begin.
Finra, the regulator for brokerages, doesn’t track this shadow margin, nor does the SEC. Both, however, have been warning about the risks. No one knows the overall amount of this shadow margin, but some details have been reported:
Morgan Stanley had $36 billion of these loans on its balance sheet as of the end of 2016, up 26% from 2016, and more than twice the amount in 2013.
Bank of America Merrill Lynch had $40 billion in SBLs on the balance sheet at the end of 2016, up 140% from 2010;
UBS and Wells Fargo “also have made billions in such loans, people familiar with those banks” told the Wall Street Journal. Raymond James, Stifel Nicolaus… they’re all doing it.
Fidelity used to fund its own SBLs for its clients, but three years ago partnered with US Bancorp.
Even the little ones are trying to get their slice of the pie: In April, robo-advisory startup Wealthfront, with less than $6 billion, announced that it would offer SBLs to its clients.
And now Goldman Sachs, which has been offering SBLs to its 12,000 super-wealthy clients through its Private Banking unit — accounting “for more than half of the unit’s $29 billion in loans outstanding,” according to the Wall Street Journal — announced on Thursday that this wasn’t enough and that it is partnering with Fidelity Investments to spread these loans far and wide.
This effort to lever up investors’ portfolios occurs after an eight-year bull run, with stock indices hopping from one all-time high to the next even as the economy has been growing at a dreadfully slow pace and even as corporate earnings have mostly gone nowhere for years.
Since July 2012, the trailing 12-month “adjusted” earnings-per-share of the companies in the S&P 500 rose just 12% in total. Over the same period, the S&P 500 Index itself soared 80%.
These adjusted earnings are now back where they’d been on March 2014. Three years of earnings stagnation. However, over the same three-plus years, the S&P 500 index has soared 33%.
As earnings have stagnated while stock prices have jumped, the P/E ratio for the S&P 500 companies has soared from 14.8 at the beginning of 2012 to 24.8 now. And bonds have seen an enormous bull run too.
It is at these precariously high levels of the markets that brokerages go into hyper-drive to push “shadow margin” on their clients, using inflated securities as collateral. If markets decline, brokerages start making margin calls, and investors will be forced to sell securities into a falling market at the worst possible time, or else the brokerage will liquidate their portfolios. Investors could lose every dime in their accounts and might be personally responsible for the remainder of the debt.
After eight years of bull market, no one is thinking about risk anymore.
Goldman Sachs will offer these SBLs to about six million accounts managed by 3,850 brokers and wealth managers that use Fidelity’s technology, though they will not be available to Fidelity’s own retail brokerage or wealth-management clients. The Journal:
The centerpiece of the action is a new online platform, called GS Select, that will offer loans of between $75,000 and $25 million, with borrowers’ portfolios of stocks and bonds serving as collateral, the companies said Thursday. Goldman’s software can analyze the holdings and make a decision within a day about how much to lend and on what terms.
Andrew Kaiser, head of Goldman Sachs Private Banking, told The Journal that this partnership with Fidelity is just the first of several:
Small wealth advisers and independent broker-dealers are good fits because they aren’t already connected to a bank, he said.
What’s in it for brokerages?
SBLs are a source of revenue that replaces some of the revenue brokerages lost as they’re moving away from charging commission on trades to charging fees on assets under management. When clients need money, they’d normally sell some securities and withdraw the proceeds from the account. This would lower the asset balance of the account, and therefore the fees for the broker. So brokerages encourage clients to leave their assets intact and add a big loan to the account. This keeps the asset-based fee intact, and the brokerage also earns interest income on the loans.
Everyone at the brokerage benefits from the deal. The Wall Street Journal:
Several Merrill Lynch brokers said they have asked longstanding clients to open securities-backed lines of credit to help them hit bonus hurdles, assuring that clients wouldn’t need to use it or pay any fees for opening it. Merrill brokers receive ongoing payments for getting clients to tap credit lines, and those loan balances contribute to year-end bonus calculations, people familiar with matter said.
Brokerage executives have said the longer a client has one of these loans tied to their account, the more likely they are to use it.
“We were dramatically pushed to put these on all of our client accounts,” said Steven Dudash, a former Merrill Lynch broker who has been managing his own investment-advisory firm since 2014. “Whenever you’re product-pushing, it’s not in the client’s best interest.”
What’s in it for their clients?
Clients get to pile on low-interest-rate debt and huge risks, including the chance of losing more than all the assets in the account if push comes to shove in the markets and their collateral value gets crushed. They will have to sell into a crash at the worst possible time, and even after they sold all their assets, they might still owe the broker, and the broker will go after them for the remaining debt. The Journal explains:
These arrangements are structured to benefit the brokerage, with the client shouldering virtually all the risk, critics say. And these loan products are often pushed without regard to whether clients even need them, they add.
There is another side effect to this margin debt, whether it is out in the open, like NYSE margin debt, or the shadow margin of those SBLs: When markets decline and forced selling kicks in, it causes a further decline in the market, which causes even more forced selling.
Leverage has been the great accelerator on the way up over the past eight years. And it’s also the great accelerator on the way down.